Does anticipation of government spending matter? Evidence from an expectation augmented VAR

How does private consumption react to an exogenous increase in government expenditure? Standard structural vector autoregressions (SVARs) usually report a positive GDP as well as consumption response, while event studies report a negative consumption response. We investigate in a SVAR whether anticipation of the fiscal shock reverses the sign of this dynamic response to a negative one. As a methodological contribution, we model expectation formation within a SVAR framework. We show for the US that consumption falls in reaction to an expenditure shock once the model allows for one-period-ahead anticipation of this shock. Modelling anticipation of fiscal shocks is thus crucial to correctly capture their macroeconomic effects. Differences in results between event studies and VARs can be explained by missing anticipation in VARs. When re-estimating the two models (with and without anticipation) for non-defense related expenditures, we find a positive consumption response for both models. The implications of our results for macroeconomic theory are briefly discussed. --Fiscal policy,government spending,net revenue,policy anticipation,structural vector autoregression

Does anticipation of government spending matter? The role of (non-)defense spending

We investigate the effects of government expenditure on private consumption when the private sector anticipates the fiscal shocks. In order to capture anticipation of fiscal policy, we develop a new method based on a structural vector autoregression (SVAR). By simulating data from a theoretical model featuring (imperfect) fiscal foresight, we demonstrate the ability of our new approach to correctly capture macroeconomic dynamics. We take advantage of the flexibility of our econometric approach and study those subcomponents of total government spending, which have different macroeconomic effects according to economic theory. Using post-WWII US data, we find that when taking into account anticipation, private consumption significantly decreases in response to a defense expenditure shock, whereas when considering shocks to non-defense spending, consumption increases significantly. A standard SVAR does not produce clear consumption responses, highlighting the importance of anticipation. Our results thus reconcile the different findings of the narrative and SVAR approaches to the study of fiscal policy effects.fiscal policy anticipation, SVAR, consumption response, government spending

Essays in Econometrics and Macroeconomics

From a global perspective, this dissertation illustrates the consequences of choosing a particular balance between completeness and manageability in terms of model building, both in the field of macroeconomics and econometrics. Each of the three chapters shows that there are potentially dramatic consequences of taking into account, in a manageable way, additional and – with respect to the question at hand – essential layers of reality. In particular, in terms of econometric theory, Chapter 1 demonstrates that considerably more precise estimates within a dynamic factor model are obtainable by employing simple two-step estimators taking into account additional features of the data-generating process. Chapter 2, furthermore, considers a macroeconomic model featuring labor market frictions. It highlights the important consequences for equilibrium allocations and optimal monetary policy when altering the central aspect of the wage determination mechanism, so that it is consistent with empirical evidence. Finally, Chapter 3 presents an empirical investigation, studying the effects of fiscal policy on the macroeconomy. In this regard, it demonstrates the importance of allowing for particular features of the information structure as well as of distinguishing certain subcomponents of the fiscal variables, which might have different macroeconomic effects as implied by economic theory. As a result, we can illustrate that while at a certain level of abstraction, the findings of different approaches in the literature seem to be in conflict with each other, at another level the antagonism vanishes. More specifically, Chapter 1 considers efficient estimation of dynamic factor models. A simple two-step estimation procedure is suggested to obtain efficient estimates in the presence of both heteroskedasticity and autocorrelation. Interestingly, with respect to the factors, it is only potential heteroskedasticity which has to be taken into account, whereas for the loadings the relevant aspect is just autocorrelation. While, as we show, the feasible two-step PC-GLS estimator is asymptotically as efficient as the estimator that (locally) maximizes the full approximate likelihood function, small sample gains may be obtained by iterating the two-step estimator. This is indeed reflected in the results of our extensive Monte Carlo investigation. Moreover, we also document the superior performance of the two-step PC-GLS estimator compared to standard PC. Chapter 2 studies optimal monetary policy using a simple New-Keynesian model featuring labor market frictions, heterogeneous wage setting, as well as markup shocks. Replacing the typically used uniformly rigid wage by a form of wage heterogeneity consistent with the data, has profound effects on the policy implications of this model. In particular, the sizable short-run inflation unemployment trade-off, which is present in the original setup, disappears. This results despite the fact that the original setup is just slightly changed and even though the model features an economy-wide average wage which is still rigid. As an overall rigid real wage is typically employed to address the so-called unemployment volatility puzzle, I follow suggestions in the literature with respect to an alternative mechanism and introduce markup shocks as additional driving forces into the model. While a short-run inflation unemployment trade-off indeed arises in this setup, optimal policy is nevertheless characterized by an overriding focus on inflation stabilization. In light of the conflicting empirical results concerning the effects of fiscal policy on the macroeconomy and the potentially important role of fiscal policy anticipation in this regard, Chapter 3 investigates the response of private consumption to fiscal shocks within an SVAR framework, explicitly taking into account fiscal foresight. A new empirical approach is suggested, designed to align the information sets of the private agents and the econometrician, which allows us to avoid the problems of standard VARs. A simulation experiment based on a theoretical model featuring (imperfect) fiscal foresight documents the ability of the approach, in contrast to a standard VAR, to correctly capture macroeconomic dynamics. This result is even robust to deviations from the underlying informational assumptions of the expectation augmented VAR. The subsequent application to real life data indicates that it is indeed important in empirical work to allow for anticipation of fiscal policy. Moreover, it shows that it is crucial to distinguish subcomponents of total government expenditure which might have different macroeconomic effects according to economic theory. By distinguishing government defense and non-defense spending, it is possible to reconcile the results of the narrative and SVAR approaches to the study of fiscal policy effects

The macroeconomic effects of exogenous fiscal policy shocks in Germany: a disaggregated SVAR analysis

We investigate the short-term effects of fiscal policy shocks on the German economy following the SVAR approach by Blanchard and Perotti (2002). We find that direct government expenditure shocks increase output and private consumption on impact with low statistical significance, while they decrease private investment, though insignificantly. For the sub-category government investment – in contrast to government consumption – a positive output effect is found, which is statistically significant until 12 quarters ahead. Allowing for anticipation effects of fiscal policy does not change the sign of the positive consumption response. Anticipated expenditure shocks have significant effects on output when the shock is realized, but not in the period of anticipation. In sum, effects of expenditure shocks are only short-lived. Government net revenue shocks do not affect output with statistical significance. However, when splitting up this aggregate, direct taxes lower output significantly, while small indirect tax revenue shocks have little effects. Compensation of public employees is equally not effective in stimulating the economy. --Fiscal policy,government spending,net revenue,policy anticipation,structural vector autoregression

The Macroeconomic Effects of Exogenous Fiscal Policy Shocks in Germany: A Disaggregated SVAR Analysis

We investigate the effects of fiscal policy shocks on the German economy extending the SVAR approach of Blanchard and Perotti (2002). Direct government expenditure shocks are found to increase output and private consumption on impact. The output multiplier is smaller than one and is falling rather quickly reaching zero after 3 years. Government operating expenditure has sizeable positive effects on output, in the long run in particular due to public capital formation. Compensation of public employees is not effective in stimulating the economy.Government net revenue shocks do not affect output significantly. Indirect taxes have little effects, while direct taxes lower output significantly. Overall, the effects of fiscal policy are short-lived with the exception of public investment increases.Fiscal policy, government spending, net revenue, structural vector autoregression